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The Multi-Business, Diversified

Firm

MANEC 387

Economics of Strategy

David J. Bryce

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Corporate vs. Business Unit

Strategy

Business Unit Strategy

To whom will we sell, for what price?

How will we source, manufacture, distribute, etc.our product?

Corporate Strategy

What business(es) should we be in?

How will we get in (or out) of them?

How will we coordinate or integrate businesses tocreate value?

Adapted from M. Porter, 2001, HBR

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Corporate-Level Strategy and the

Multi-business Firm Corporate strategy is action taken to gain competitive

advantage through multiple business units

Value is created through the configuration andcoordination of multi-business activities

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Scope of the Firm

Horizontal Scope

Ve

rticalScope

Manuf.

Distrib

Sales

Prod./Ind. A

Manuf.

Distrib

Sales

Manuf.

Distrib

Sales

output-products

Prod./Ind. B Prod./Ind. C

Manuf.

Distrib

Sales

Manuf.

Distrib

Sales

Manuf.

Distrib

Sales

. . .

Input-produc

ts

.

.

.

VerticalIntegration

Horizontal Integration

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Wal-martHorizontal Scope

VerticalScope

Manuf.

Distrib

Sales

Prod./Ind. A

Manuf.

Distrib

Sales

Manuf.

Distrib

Sales

output-products

Prod./Ind. B Prod./Ind. C

Manuf.

Distrib

Sales

Manuf.

Distrib

Sales

Manuf.

Distrib

Sales

. . .

Input-pr

oducts

.

.

.

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GEHorizontal Scope

VerticalScope

Manuf.

Distrib

Sales

Refrigerators

Manuf.

Distrib

Sales

Manuf.

Distrib

Sales

output-products

Aircraft Engines Prod./Ind. C

Manuf.

Distrib

Sales

Manuf.

Distrib

Sales

Manuf.

Distrib

Sales

. . .

Input-pr

oducts

.

.

.

Compressors

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Why Diversify?

Secure Market Power

Cross-subsidization, mutual forbearance,reciprocal buying

Shown to be an incomplete, if not an incorrectview

Mitigate Business (Cycle) Risk

Perspective from finance Few firms are just portfolio investors

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Why Diversify?

Achieve Efficiency (or Synergy)

Pursue related or complementary activities

Most common type of diversification

Associated with higher levels of performance than previous twotypes

Dynamic Learning

Related to the efficiency motivation

Firms invest in activities that leverage existing skills andknowledge

Firms introduce new activities to build skills and knowledge

Objective is to develop a capabilities portfolio that is ready fornew opportunities when they emerge

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Transaction Costs and

Diversification Hierarchical organization (as within a firm) is

a governance mechanism that reduces thecosts of transactions that would otherwiseoccur across markets or not at all E.g. Complex contracting environments (recall our

discussions on Hold-up)

Contracting for specific assets

Certain types of knowledge assets

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How to Choose Industries/Products for

Expansion1. Strategically Important

2. Strategically Related; i.e. commonality

in one of the following:1. Customers

2. Channels

3. Inputs4. Processes

5. Market Knowledge

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Evaluating Diversification

How can diversification create value?

Economies of scope

Learning How can diversification dissipate value?

Bureaucratic costsinformation overload, coordinationlimitations

Over-extension for management know-how,financial, or other resources

Empire building without incremental value-add

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Sequential Entry and Dynamic

Learning: Example

Texas InstrumentsTexas Instruments

IBMIBMComputerStorage

Devices (3572)

Electronic

Computers (3571)

ComputerTerminals (3575)

Computer

Peripherals (3577)

Software (7372)Semi-conductors

(3674)

Semi-

conductors

(3674)

Electronic

Computers (3571)

Search &Navigation (3812)

Software (7372)Texas InstrumentsTexas Instruments

IBMIBMComputerStorage

Devices (3572)

Electronic

Computers (3571)

ComputerTerminals (3575)

Computer

Peripherals (3577)

Software (7372)Semi-conductors

(3674)

Semi-

conductors

(3674)

Electronic

Computers (3571)

Search &Navigation (3812)

Software (7372)

Source: COMPUSTAT Business Segment Files, 1977-1996

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Patterns of Historic Entry in Industries

Related to Semiconductors, 1977-1996

Semiconductors

(3674)

Engineering

Services

(8711)

Computer Storage

Devices

(3572)

Radio/TV

Communication

Equip

(3663)

Computer

Peripherals

(3577)

Electronic

Components

(3679)

Patent Owners &

Lessors

(6794)

Search &

Navigation Equip.

(3812)

Process Control

Instruments

(3823)

Electronic

Capacitors

(3675)

Printed Circuit

Boards

(3672)

Special Industries

Machinery

(3559)

*

(***)***

*

*

*** (*)* (*)***

(*)(*)

*** (*)

*

*

* p

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Summary and Takeaways Corporate Strategy is about structuring a

portfolio of businesses that hang togetherand make strategic sense

It is sometimes motivated by economizing ontransaction costs

Other (strategic) motivations include dynamiclearning, efficiency, or sometimes market

power and risk management Diversification is not a fail-proof strategy